In GIS, Reference Scale is the scale at which symbols and labels appear on a map at their intended, true size.
In ArcGIS Desktop, when reference scale is set to a specific scale, and the zoom extent is changed, the text and symbols change scale along with the display (and accordingly, the map). With no reference scale, symbols and labels dynamically adjust to look the same at all map scales. ArcGIS Desktop uses reference scales for annotation groups, geodatabase annotation, feature classes, geodatabase dimension feature classes, and data frames.
In the first example, the two map images below show the same map at different zoom levels. Because no reference scale is set, the label text size dynamically changes to remain the same at both zoom levels. This is the result of the adjustment made in ArcMap as zoom levels change to ensure that you can always see and read labels and symbols when making a map.
In the second example, reference scale is set to a specific scale that renders the labels at the size they should appear on the map, regardless of zoom level. Below, the the text labels in the map on the left are set to approximately the correct scale for the example map, so you set the reference scale when at this scale. After setting the reference scale, the map on the right is the same map zoomed out.
Setting reference scale effectively locks the label size relative to the map, and the labels do not dynamically adjust to accommodate viewing on screen, and accordingly get smaller as the map is zoomed out to a larger scale. Setting reference scale also ensures your map labels and symbols appear the right size when printed or output to other formats.
Setting Reference Scale in ArcMap
The easiest way to set Reference Scale to the appropriate scale is to zoom to various levels and select the most appropriate size level for the most important symbols and text relative to the features they denote. If you are not sure about what is appropriate, looking at other maps to get ideas about how other cartographers have done it is a good place to start.